This action might not be possible to undo. Are you sure you want to continue?
Who owes whom?
Here is one little area that sometimes causes confusion. You are no doubt familiar with the terms debit and credit. It helps to remember that the words are derived from debt (in this case an amount owed to you), and creditors (people to whom you owe money). Your accountant treats them as follows.
N Asset accounts have debit balances. If you extend credit to a customer you
debit accounts receivable for that customer (indicating that the money is owed to you); similarly – but perhaps stretching the concept – if you buy a clump press you debit machinery. The machine owes you money.
N Liability accounts have credit balances. If you borrow money you credit, say,
short-term loans from the bank (that is, the bank is your creditor).
N Expense accounts have debit balances. This is easy. When you pay out money,
you debit the expense account. When you pay ofﬁce rent, you debit ofﬁce rents paid.
Fig. 7.3 When financial transactions count
Your year planner has the date of your August holiday marked, I would guess, against August. It would not be so helpful for work scheduling purposes if you marked it on the day that you decided on Jamaica, or when you paid the deposit. So it is with ﬁnancial transactions. For analytical purpose, debits are matched against the related credits, and they are each matched to the appropriate period of activity. This is not necessarily the same as the date when money changes hands. One example should sufﬁce. Suppose that:
you are producing a monthly expenditure plan; your ofﬁce rent is $1000 a month; and N you pay it once every three months in advance. For example, on 28 June you pay the $3000 that relates to calendar months July, August and September. The accounting entries are shown on the right. 1 In June, you credit (reduce) your bank balance by $3000 and debit (increase) the asset account prepaid rents by the same amount. 2 In each of July, August and September, you debit (increase) ofﬁce rental payments by $1000 and credit (reduce) prepaid rents by the same amount. If the only other transaction is a 10 000 share issue in May, the transactions that show in your ﬁnancial statements are as follows. Note the way that a change in the balance sheet between two dates (e.g., the change in prepaid rents between the end of June and the end of July) equates to a ﬂow in the intervening period (P&L account – rents paid in July). This is examined in more detail in Chapter 9.
When you show an increase in your bank deposit you show a debit entry – the bank owes you more. current year Total Proﬁt & loss account Whole month Ofﬁce rental payments Net proﬁt (loss) Cash ﬂow Whole month Share issue Ofﬁce rental payments Total for month Net cash balance 10 000 0 10 000 Jun Jul Aug Sep 7 000 3 000 10 000 7 000 2 000 9 000 7 000 1 000 8 000 7 000 0 7 000 10 000 0 10 000 10 000 0 10 000 10 000 (1 000) 9 000 10 000 (2 000) 8 000 10 000 (3 000) 7 000 0 0 0 0 1 000 (1 000) 1 000 (1 000) 1 000 (1 000) The changes in the balance sheet are ﬂows in the other accounts 1 0000 0 1 0000 1 0000 0 –3 000 –3 000 7 000 0 0 0 7 000 0 0 0 7 000 0 0 0 7 000 131 . This is the exact opposite of what we normally say. This is because you are then looking at it from the bank’s perspective. in your company accounts you show a credit to the bank – the bank owes you less. When you put money on deposit you become one of the bank’s creditors. if you are drawing up a business plan for a bank. May Balance Sheet End month Assets Cash at bank Prepaid rents Total Liabilities and shareholders’ equity Paid up share capital Proﬁt (loss). It is straightforward if you look at it from the view point of who owes money to the business.The way that bean counters think The area of confusion is that when you take money out of your bank deposit account. When you go into your bank to put money into your account you ﬁll in a credit slip not a debit slip. Thus. customer deposits are liabilities with credit balances and loans to customers are assets with debit balances.
are no more than proﬁt and loss and cash ﬂow forecasts by another name (usually monthly). if you have monthly ﬁgures for the ﬁrst year and annual ﬁgures for the remaining term. You can add together ﬁnancial ﬂows. the planning horizon will already have been staked out – probably three or ﬁve years hence.7 N About these numbers The planning horizon The planning horizon is the most distant point in the future that you will visit in the plan. It is preferable to think of a budget as an operational ﬁnancial plan – not as a budget that must be spent. Essentially. The budget is the forecast that you adopt as representing your best guess at the future.” Chinese proverb 132 . the production department could operate on a ﬂexible budget. For example. “If the profits are great. The ﬁgures for the month ending 31 December are the ﬁgures for the end of the fourth quarter and for the end of the whole year. Do not add balance sheet ﬁgures. Good business plans usually contain monthly ﬁgures for the ﬁrst year. If you happen to be working on a plan covering longer than this. Sometimes it does not make sense to operate within a ﬁxed budget. include a summary for the early part of the plan for ease of comparison. the budget is saying if our assumptions about our operating environment are correct this is how much we will spend and receive. show annual ﬁgures for the ﬁrst year also. For example. They show the end-period balances. and quarterly or maybe only annual numbers for the remaining years. the risks are great. used for planning and measuring performance. If you have mixed periods. The sum of the expenditure ﬁgures for the 12 months January to December gives you total spending for the calendar year. Forecasts and budgets A budget is a misleading name for a set of ﬁnancial projections or forecasts that have been formalized as: N an operating plan. Budgets. N for a given period of time – usually one year. when sales are very unpredictable. By the time you start work on the ﬁnancials. The production manager might be authorized to increase spending by $100 000 for every extra 10 000 units of production above a pre-agreed volume. you probably will not want to attach much credibility to forecasts more that ﬁve years out. and N a set of ﬁnancial targets.
As discussed in the text. Perhaps it looks a little complex.4 you are in doubt.4 Financial relationships exposed This diagram shows the interrelationships between the three sets of transactions and the three ﬁnancial statements. turn it into a product. please interpret references to months as your shortest accounting period. which shows balances at a point in time. Also. If FIG 7. Most businesses use a 12-month period Fig. except the balance sheet. Some businesses – such as retailers – use a fourweek accounting period to help compare like with like. I tend to use the term year to mean the longer of a year or an operating cycle – the amount of time that it takes to buy stuff. the changes in balance sheet between two dates reveal ﬂows. costs Profit and loss Sales Less cost of sales = Gross profit – Operating costs = Net profit 133 .The planning horizon How long is a month? To save me having to use complicated phrases. but it is actually quite simple. Accounts receivable Sales Sales Change in inventory Materials consumed + Depreciation + Production costs = Cost of sales Cash at bank Liabilities Accounts payable Accrued expenses Loans Owners' equity Capital Retained earnings Operating costs Employee costs + Depreciation + Other expenses = Total op. and collect cash from the lucky buyer. They always begin on the same shopping day. etc. Remember that all the accounts show ﬂows over time. Capital outlays Fixed assets at cost – Depreciation = Net fixed assets Balance sheet Assets Cash flow Net profit – Fixed assets + Depreciation + Paid not expensed + Sales on credit – Expensed not paid = Net cash flow Fixed assets at cost – Depreciation = Net fixed assets Inventory Prepayments. 7. the relationships will become evident as you work through Chapters 7–10 of this book.
If you are involved with non-proﬁt organizations. A $10 000 increase in net ﬁxed assets could conceal a $15 000 acquisition and $5000 of depreciation.” Chinese proverb 134 . When and how you use the data that you extract is also discussed below. t It’s the same. It is the same for historical periods and forecasts. say. Looking back There is little need to dwell on how you ﬁnd the historical ﬁgures that you need for your business plan. an increase in spending in reclassiﬁed or summarized ﬁgures. Don’t try it. Professional number crunchers are good at spotting this. It might run for some other period that is convenient for you. N Policy decisions and changes in practices mislead. In other words. in this case you will almost certainly have or be able to obtain historical examples that you can mimic in your business plan – and the broad principles are exactly the same as those discussed here. even if you are not in it for the money Much of the discussion here might appear to focus on the ﬁnancials for business.7 N About these numbers – ﬁscal year – that sometimes coincides with the calendar year. If you are starting a new business and you want to spoil your accountant’s new year’s eve celebrations. choose a ﬁscal year that matches the calendar year. You just extract them from your records. The ﬁgures that you need were introduced in Chapter 4. perhaps coinciding with the tax year. government agencies or similar bodies. when moving through history to the current ﬁgures and on to forecasts. try to make sure that the numbers are presented consistently. The only warnings to consider are that sometimes: N Summarized ﬁgures hide things. I will expand on them in the following pages. Where a change in accounting policies causes lumpiness in the numbers. include an additional line that shows the earlier ﬁgures presented on the same basis as the forecast and explain what is going on. “Consider the past and you will know the future. your ﬁnancial statements will look a little different. I am sure that you would never attempt to hide. However. A decision to write-off a long-standing bad debt might suggest a reduction in assets when actually nothing fundamental has changed.
You will have a reasonable idea of the transactions yet to be recorded in the accounts. It may be that when you see the bottom line you will need to work back through the Six steps to painless financial forecasts 1 Project sales revenue. 5 Draw up a balance sheet (another largely mechanical step). The ﬁrst three steps require varying degrees of thought. “The trouble with facts is that there are so many of them. 3 Work through the remaining operating costs. Then deduct the cost of those sales (raw materials. Cash ﬂow projections reveal your funding requirements – or cash surplus. try not to make it arithmetically dependent on the ﬁgures that you are forced to estimate and are likely to change. A $30 000 machine with a three-year life ‘costs’ you $10 000 a year. This is the most important step. 6 Check your cash ﬂow requirements (also a mechanical restatement of the foregoing numbers). Multiply these by price to convert them into the value of gross sales revenue. etc. You should forecast sales volumes (quantities).) to arrive at gross proﬁt.” Samuel McChord Crothers 135 . You can ﬁrm up on these as the planning exercise progresses. As discussed. It is all much more straightforward than it might appear at ﬁrst glance. It builds on the market analysis that you have already done. 2 Identify the capital spending required. 4 Derive a proﬁt and loss (income) statement – a simple mechanical exercise using basic arithmetic on the results of the ﬁrst three steps. payments to suppliers. such as sales executives’ salaries and telecommunications costs. The second three are mechanical. To avoid making frequent revisions to the forecast. Crystal ball gazing There are six steps to painlessly producing successful forecasts. listed below. Filling in gaps in the ﬁgures for the current year is more a matter of estimation than forecasting. you need to treat these slightly differently from other operating costs by spreading the outlays over their assumed operating life.Crystal ball gazing Estimating the present I have mentioned already that you often ﬁnd yourself preparing forecasts for next year when this year is not yet over.
136 . You sometimes hear this referred to as ‘scenario planning’. because it shows that you have thought about all eventualities. you can refer to what-if using the term sensitivity analysis. You should start out by adopting the policy that you will amend the sales projections only if you ﬁrst change the sales and marketing strategy and/or plan. It is a very important part of your business plan. Your readers probably do expect them. or to encourage an investor or banker to pour money into your business. This might involve revisiting the marketing strategy or some other part of the plan. What if your competitor introduces a superior product at half the price? What if there is an economic disaster? What if it takes you twice as long to ﬁx the bugs in the new software? If you want to make it sound deep and meaningful. What if …? Producing a single ﬁnancial forecast is not the end of it. In fact. It may be that you want to produce a bestcase as well to please the boss. If you make one or two assumptions about your business there is a neat way to show the degree of conﬁdence that you attach to various outcomes. the second and subsequent forecasts are the result of common sense whatif analysis. You might not think that these extremes will happen.7 N About these numbers numbers to bring the funding requirement into line with reality – or to put the surplus to good use. This will show you the amount of funding that you would need if a doomsday scenario plays out. Sometimes even most-likely and worst-case forecasts are not enough. Most business people – and all solid business plans – require at least a second pass through the forecasting exercise to produce a worst-case projection. The most dangerous thing you can do if the funding requirement is too large is cheat by adjusting the revenue forecast on the basis that you probably underestimated sales in the ﬁrst place. This is also discussed in Chapter 11. We will return to this in Chapter 11.
You do not need to be a spreadsheet wizard. or perhaps you underestimated the amount of time required for cutting through all the red tape. If you are not familiar with spreadsheets. the three ﬁnancial statements on one page. maybe other activities cause delays. N enter simple formulas that add. say. These can be six separate worksheets – or you could combine. It might take longer to raise capital. Make sure that you never enter the same information more than once. the balance sheet and cash ﬂow. Corporate bosses and capital providers are rarely so accommodating. In my experience. proﬁt and loss.9) use month 1. consider replacing dates with numbers. It is enough to know how to: N format a cell so that the layout is pleasing. operating costs. multiply or simply repeat other values. These plans will never look out of date. you might think that a July launch date is entirely feasible. t Which is the first month? Overheard in a corporate ﬁnance department: Look at the age of this business plan. 8. Here are four useful tips. When you start to write the plan in January. It’s still not funded. explain the basic principles and guide you through the groundwork. The extracts from sample business plans shown here (for example. These give you worksheets – tables with blank cells. into which you type information – that collect together into workbooks. It shows that the project should have started two months ago. one for each of sales. you are certain to have a colleague. they convey a bad impression. in the detailed ﬁnancial projections. ensure that all other instances of the dates pick up the values from 137 . 1 Minimize data entry. new ventures nearly always start later than expected. To avoid having to revise and reprint business plans. if you key in the months across the top of one spreadsheet. or boxes. capital outlays.Software tools Software tools The way to tame your numbers and keep it under control is to use a computer spreadsheet. friend or relative who loves their computer and will be only too pleased to set this up for you. You might also decide to include worksheets for any additional tables that you produce in pursuit of your analysis and forecasts. If not you might consider a training course or evening classes. month 2. etc. such as MS Excel or Lotus 1-2-3. Maybe 20 other people have seen it and rejected it already? Business plans date rapidly – and when they do. month 3. see Fig. For example. Spreadsheet techniques You should set up a workbook that essentially contains six tables. If you can use the facility to draw charts you are in a strong position. This is especially true of plans for new projects or business start-ups.
02 … ='SUNDRY'!E45 =SUM(E4:E28) =E3+1 =E4 … =E9*1. the next eleven cells could be set as formulas Fig. For example. you only have to make one amendment and the changes will ripple through all the spreadsheet. Jan-2001) into cell one.02 … ='SUNDRY'!D45 =SUM(D4:D28) =D3+1 =D4 … =D9*1.7 N About these numbers the ﬁrst row. Try to automate data entry further. 7.02 … ='SUNDRY'!F45 =SUM(F4:F28) =A3 =’GROSS’!A99 Less expenditure Net proﬁt =B3 ='GROSS’!B99 =B29 =B33-B34 =C3 ='GROSS'!C99 =C29 =C33-C34 =D3 ='GROSS'!D99 =D29 =D33-D34 =E3 ='GROSS'!E99 =E29 =E33-E34 =F3 ='GROSS'!F99 =F29 =F33-F34 What you see: A 1 2 3 4 … 14 … 28 29 30 31 32 33 34 35 36 Operating costs Year Salaries … Telecomms … Sundry costs Total expenditure P&L summary Year Gross proﬁt Less expenditure Net proﬁt B C D E F 1999 10 000 … 1 000 … 143 23 967 2000 10 000 … 1 020 … 453 25 333 2001 10 000 … 1 040 … 122 24 666 2002 10 000 … 1 061 … 36 24 921 2003 10 000 … 1 082 … 445 24 921 1999 45 654 23 967 21 687 2000 34 566 25 333 9 233 2001 37 543 24 666 12 877 2002 35 567 24 921 10 546 2003 35 468 24 921 10 547 What it means: A 1 2 3 4 … 14 … 28 29 30 31 32 33 34 35 36 Operating costs Year Salaries … Telecomms … Sundry costs Total expenditure P&L summary Year Gross proﬁt Less expenditure Net proﬁt B C D E F 1999 Each cell displays the value in the cell to its left incremented by 1 10 000 Each cell displays the value from the cell to its left … … 1 000 Each cell displays the value in the cell to its left increased by 2% … … Each cell displays the corresponding value from the worksheet called 'Sundry' Each cell displays the sum of the values above Each cell displays the corresponding value from row 3 Each cell displays the corresponding value from row 29 Each cell displays the corresponding value from the worksheet called 'Gross' (proﬁt) Each cell displays the value in row 33 less the value in row 34 138 .5 Spreadsheet magic What you entered: A 1 2 3 4 … 14 … 28 29 30 31 32 33 34 35 36 Operating costs Year Salaries … Telecomms … Sundry costs Total expenditure B Only three new ﬁgures C D E F 1999 10 000 … 1 000 … =’SUNDRY’!B45 =SUM(B4:B28) =B3+1 =B4 … =B9*1.02 … ='SUNDRY'!C45 =SUM(C4:C28) =C3+1 =C4 … =C9*1.g. if you key a monthyear (e. Then. 2 Automate.. The same goes for numerical amounts such as number of employees or spending on salaries. if you change the coverage period of the ﬁnancial statements.
139 . But where you have to show more than six months for a ﬁnancial statement or forecast. see you in Chapter 8. t Squeeze it in A venture capital provider I knew generally asked for detailed ﬁnancials for the ﬁrst six months only. Changing the value in the ﬁrst cell will cause all 12 months to be updated automatically. and for broad expectations thereafter. You then have consistent ﬁnancial plans for the whole business and its constituent parts. Again. When you get these workbooks back. This is a sensible approach. you can give copies to R&D. If you project that rent will rise in period two. put a formula in the second cell that displays 110% of the ﬁrst cell. which is discussed in Chapter 13. and so on for them to complete during the planning exercise. It’s a good idea to use one colour to display the characters in the cells into which you key raw data (say. you can use an additional identical workbook to automatically aggregate the numbers for the constituent departments. For example. To ensure a painless interaction between the worksheets. the same applies to numerical data. you will ﬁnd that it is usually possible to squeeze in 15 columns (line number. He maintained there are so many variables for a start-up that it is pointless trying to look further ahead.Putting it to good use that calculate the value of the previous cell plus one month. Make sure that you have understood the concepts raised in this chapter. black) and another colour for all automated cells (say. Marketing. including tracking actual spending against budget. When you have a standard workbook. You can then see at a glance which is which. blue). 3 Carry forward totals. In fact. twelve months and a total) on one sheet of A4 or letter paper. But I usually print the ﬁnal version in black only – to avoid distracting other users. When you are. crystal ball gazing and spreadsheets should have set you in good stead for the rewarding task of working out your ﬁnancial prospects. Putting it to good use This introduction to accountancy’s idiosyncrasies. description. You can always turn it sideways or spread over two pages. The workbooks can also be used for operational purposes. the current-year proﬁt (loss) in the balance sheet should be taken directly from the bottom line on the proﬁt and loss account (which is calculated as the sum of individual entries). 4 Use colour. I take this a stage further and use red print for cells which are mechanical projections so that it is easy to see where the assumptions are that might be modiﬁed during a review process. I can’t wait. use formulas to carry forward totals.
This action might not be possible to undo. Are you sure you want to continue?